Aussie dollar set to dive…and take your wealth with it

Aussie dollar set to dive…and take your wealth with it

Will they or won’t they?

That’s the big question this week.

The Reserve Bank of Australia meets next Tuesday…and there’s a 50/50 chance of a rate cut, according to the markets.

This sort of even spilt on a rate change tells us that even the experts are confused as to which direction our central bank is going to take.

As an investor, it’s not what the folks at Martin Place will do next week — or even the month after — that’s important.

No.

The sentiment coming out of our central bankers will have a longer-term impact on your wealth

Even the bankers don’t know

I’m not one for patting central bankers on the back.

But in the past couple of years, the Reserve Bank of Australia has done well not to bow to political pressure to move interest rates.

Yet, after last month’s inflation data showed 0.0% growth for the March quarter, many of the headlines are calling for a rate cut.

The boffins at Martin Place aren’t ones for doing things in favour of popular opinion.

Does that mean a rate cut is coming this May?

Historically, months like February, May, August or even November have often seen interest rate changes more than other months.

This is simply because all the quarterly economic data has come through, giving the central bank a ‘full economic picture’.

Nonetheless, people are confused about what may happen.

Scratch that. Even our bankers aren’t sure what the RBA will do.

Take this, for example.

On one hand, we have National Australia Bank Chief Executive Philip Chronican saying that any rate cut will have no ‘material’ impact on the economy. Chronican told The Sydney Morning Herald

I’ll leave that to [RBA Governor] Philip Lowe to make that judgement. The only observation I’d make is that when interest rates are at absolutely very low levels, the effects of further changes in interest rates are relatively muted.[1]

Then on the other hand, we have this statement from ANZ Chief Executive Shayne Elliott, who told the same newspaper a rate cut will give people ‘breathing space’ and put some ‘juice’ into the economy:

Maybe it will just give a bit of juice into the economy, and get a bit more employment, and put a bit of money back into people’s pockets. And what would that do?  Well, it would mean people have a little bit more to spend, it would mean that those customers who are struggling in terms of their mortgage would probably get a bit more breathing space.[2] 

Two completely different statements.

Two completely different takes coming from people who create money in Australia.

No wonder the average punter doesn’t know what to expect.

Like I said, even I don’t have a firm opinion on this. Given how opinionated I am about pretty much everything, this is an odd position for me.

The complete absence of any inflation in the data is like waving a red flag at a bull. So a rate cut makes sense in that respect.

However, the RBA is rarely that reactionary to one set of data.

And for the past couple of months, it has emphasised the point that it’s looking at employment statistics and wage growth as its main triggers for any rate changes.

The RBA wrote the following in its April meeting minutes:

These declines had reflected lower expected paths for monetary policy, lower term premiums and, to varying extents, lower inflation expectations. 

The central scenario was for further gradual progress to be made on both unemployment and inflation. Members observed that a pick-up in growth in household disposable income was an important element of these forecasts. Given this outlook for further progress towards the Bank’s goals, members agreed that there was not a strong case for a near-term adjustment in monetary policy. 

Members also discussed the scenario where inflation did not move any higher and unemployment trended up, noting that a decrease in the cash rate would likely be appropriate in these circumstances.[3] 

Those three paragraphs essentially sum up why the market has a 50/50 view on which way the RBA will go.

In the first paragraph, our central bank says it anticipates lower inflation data for longer.

Come the third paragraph, the RBA says that if inflation did not move any higher and unemployment trended up, a rate change would be ‘appropriate’.

However, we simply have to wait until Tuesday to know what’s going to happen.

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Your takeaway today, though, isn’t what will happen on Tuesday.

Because there are much bigger problems then a potential May rate cut.

Sinking the dollar to save the economy

The problem with this central bank approach of watching, waiting and guessing isn’t the month-by-month uncertainty it creates.

My concern — and it should be yours as well — is the long-term impact of the RBA’s policies.

Low interest rates will cripple the Aussie dollar.

You see, Aussies have been lulled into a false sense of security the last few years. Compared to the rest of the world, Australia’s 1.50% cash rate seems ‘juicy’ to international investors.

The US had zero rates at one point. The EU followed suit in 2014. Japan has negative rates. And the Bank of England has kept interest rates below 0.8% since 2010.

So, the return on investment for parking cash in Australia was nothing short of incredible for yield-seeking punters.

And with China buying large amounts of Australian commodities, the Aussie dollar stayed fairly resilient.

No matter what was happening around the world, the Aussie economy defied the odds.

Our $1.6 trillion mortgage debt — roughly 80% of which is held with the big four banks — didn’t seem to drag our banking sector down.

To outsiders, our country is nothing short of an economic miracle.

And all of this sunny news brought investors to our shores.

Yet today, Aussies find themselves in a precarious position.

China is slowing its purchases from us. The US has raised rates.

The serviceability of a large chunk of Aussie mortgages is being called into question.

If people can’t make those payments on their mortgages, the Aussie banking sector will look pretty dicey to outsiders.

In the midst of all that, the biggest contributor to the Aussie economy — the consumer — is vanishing.

The good times are well and truly over, leaving our central bankers scrambling to keep things as they are.

A rate cut — whether it happens next week or a month or two after — is inevitable. Our central bankers will yank down on this lever in the hopes of maintaining the status quo.

But…these decisions will have a long-term impact on you.

The impact of a rate cut isn’t obvious at first.

And it’s highly unlikely that it will ‘juice up’ the consumer and encourage them to spend more money. It may not even prop up the housing sector like our bean counters hope.

Essentially, low interest rates will lead to the long-term erosion of your wealth.

The first sign will be even lower interest rates for the cash held at the bank.

The second sign will be the declining value of the Aussie dollar.

The third sign will be that the Aussie dollar buys less than it used to.

And this can happen quietly…in the back ground over the next few months.

The point is, the decisions the RBA makes this year aren’t going to save the Aussie economy.

They will destroy the Aussie dollar. And sink your wealth with it.

Until next time,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia